Fed eyes role of banks in physical commodities

NEW YORK  The U.S. Federal Reserve Board is embarking on a two-month consultation to consider whether the activities of banks in physical commodities pose a threat to the stability of the U.S. financial system.

Depending on how the review ends, the pressure could be on to eject U.S.-regulated banks from the physical commodities business.

Banks including JP Morgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, Barclays Capital Plc, Société Générale SA and Deutsche Bank AG have the authority to engage in physical commodities activities, and will be subject to the decision resulting from the Feds review.

Currently, those banks are allowed to engage in physical commodity trading involving the purchase and sale of commodities in the spot market, and taking and making delivery of physical commodities to settle commodity derivatives.

They are also permitted to engage in energy tolling activities as well as provide energy management services to power plants.

The review could reverse the authority granted to those banks currently active in the sector, or place tighter restrictions on their activities.

The Fed is also seeking opinion on whether banks have potential conflicts of interest by being involved in physical commodities, as well as weighing the pros and cons of imposing additional capital requirements or other restrictions on the commodity activities of banks.

The deadline for the consultation is March 15.

"The involvement of (financial holding companies) in physical commodities activities has substantially increased since 2007, primarily as a result of mergers and acquisitions and securities firms becoming bank holding companies, adding to the potential that a tail risk event affecting a global systemically important bank as a result of physical commodity activities could lead to market contagion," the Fed said.

"After reviewing the comments, the Board will consider what further action, including a rulemaking, is warranted. Comments on a proposal would also be considered before a final rule would be issued," it added.

The role of banks in physical commodities has been in the spotlight through the past year, particularly after a U.S. Senate hearing in July (amm.com, July 23).

That hearing also looked at whether U.S. banks should be allowed to own warehouses to store metal.

JP Morgan has since said it plans to exit physical commodities, while Deutsche Bank has exited the asset class entirely. European banks appetite for physical commodities is also waning amid increasing regulatory scrutiny.

At the same time, non-Western banks have noted their intentions to step up their activities in commodities, including Latin Americas largest independent investment bank BTG Pactual SA and Chinas Industrial and Commercial Bank of China.